September 12, 2016 / 6:55 PM / 3 years ago

Mexico scrambles to cut spending under shadow of credit downgrades

MEXICO CITY, Sept 12 (Reuters) - Weak growth, low oil prices and difficulties in making promised spending cuts all threaten Mexico’s push for a budget surplus next year as credit rating agencies consider downgrading its debt.

After running primary budget deficits since 2009, Mexico last Thursday pledged to turn a projected primary deficit of 0.4 percent of gross domestic product into a surplus of 0.4 percent of GDP next year.

Standard & Poor’s and Moody’s put Mexico’s credit outlook on negative this year, flagging concerns that weak growth could keep pushing up debt after a collapse in oil prices hit Mexico’s income from crude sales.

Jaime Reusche, Moody’s senior analyst on Mexico, said higher-than-expected income from tax reform passed in 2013 had helped offset the decline in oil income. But if tax revenue doesn’t hold up, the government may not meet its targets.

“The budget continues to signal consolidation and that may indeed be favorable for maintaining the rating where it is, but the proof is in the pudding,” he said on Friday.

Mexico’s austere 2017 budget lays out deep cuts that fall heaviest on the education, communications and transportation and agriculture ministries. The government proposed cuts worth nearly 240 billion pesos, or about 1.2 percent of GDP, compared to the 2016 budget.

Moody’s and S&P are concerned that debt as a proportion of GDP could keep rising in the coming years.

But Luis Madrazo, the finance ministry’s chief economist, said the government has already made deep budget cuts in 2016 to stabilize the trajectory of debt to GDP. “We need to make sure the cuts are permanent,” he said on Sunday.

Meeting the goal may be tough. Last year, when sinking oil prices sent the peso into free fall, Mexico announced spending cuts of 124.3 billion pesos, nearly 3 percent of the budget.

While the government made some cuts, total spending still overshot its original budget by more than 4 percent, or 197 billion pesos last year.

The finance ministry said in a statement to Reuters that discretionary spending without financial investments, such as absorbing part of state oil company’s Pemex’s pension liabilities, was only 1.5 percent above budget.

Reaching a surplus “is not going to be easy, the pressure is enormous,” said Ernesto Cordero, a senator in the opposition center-right National Action Party (PAN) and a former finance minister.

Mexico’s central bank last month warned that the country faced a “unpostponable” deadline to cut back its debt in order to maintain the confidence of foreign investors.

Spending last year rose nearly 5.9 percent in real terms, the biggest increase since 2008, according to a Reuters analysis of finance ministry reports to Congress.

The finance ministry said the increase was only 2.6 percent, when excluding financial investments and pension costs.

Mexico was still able to cut its total public sector borrowing requirements last year with the help of a one-off boost to its balance sheet from a surplus transfer from the central bank.

“Even if Mexico does hit the target, the quality of the adjustment is always important, not to have too many one-off items in there,” said Pramol Dhawan, an emerging markets fund manager at Pimco.

Helped by better-than-expected tax revenue, Mexico was able to map out big spending cuts at Pemex this year, easing concerns the state oil company could require a major bailout.

But spending by the federal government has been harder to rein in. One measure of discretionary spending, known as current structural outlays, rose 3.7 percent last year in real terms, shooting past the 2 percent ceiling set by the Finance Ministry in its own austerity rule approved in late 2013.

The law allows the government to exceed the limit since its recent tax reform lifted government income, according to the finance ministry.

Analysts said it would also be hard for the government to contain expenditures ahead of state elections next year after President Enrique Pena Nieto’s Institutional Revolutionary Party (PRI) lost seven gubernatorial races in 2016.

Additional reporting by Dave Graham; Editing by Simon Gardner and Jeffrey Benkoe

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